California lawmakers failed to reach agreement on how to eliminate a $42 billion budget shortfall as Governor Arnold Schwarzenegger prepares to shut down hundreds of public works projects and fire thousands of state workers.

Senate President Darrell Steinberg, a Democrat, plans to lock lawmakers in the capitol unless they pass a $40 billion package of tax increases, spending cuts and bond sales today. The bills, backed by the Republican governor and by Democrats, remain one Republican vote short.

“We are dealing with a catastrophe of unbelievable proportions,” said Senator Alan Lowenthal, a Democrat from Long Beach. “We cannot deny it any longer.”

California, a state that would rank as the world’s eighth largest economy, is close to running out of cash because its tax collections have fallen amid the U.S. recession. It has already stopped paying income tax refunds and next month may be forced to pay bills with IOUs for the second time since the Great Depression unless a new budget is agreed.

The budget proposal would raise the state sales-tax rate to 8.25 percent from 7.25 percent; boost vehicle license fees to 1.15 percent from 0.65 percent of the value of an automobile; add 12 cents to the per-gallon gasoline tax; reduce the dependant-care tax credit to $100 from $300 and impose a surcharge on income taxes of up to 5 percent.

Combined, the measures would raise taxes and fees by $14 billion, cut spending $16 billion and add $10 billion to the state’s debt. Another $2 billion in reserves would be created from funds moved on balance sheets.

Steinberg said he will put the tax increases up for a vote at 10 a.m. in Sacramento. If the measure doesn’t pass, he said he will lock senators in the capitol until an agreement is reached. “Bring a toothbrush,” he said in a speech on the Senate floor late yesterday.

Lawmakers have been unable to agree on tax increases and spending cuts in four months of talks while economic conditions worsened. The state’s looming cash shortage and political stalemate has unnerved Wall Street.

Standard & Poor’s cut the rating on $46 billion of California’s bonds to A from A+, giving it the lowest credit rating of any U.S. state.

California is one of just three U.S. states that requires more than a majority to pass a budget. That provision has empowered the Republicans, who hold enough power to block the two-thirds vote needed for passage. Republican lawmakers said higher taxes would hurt an already reeling economy.

“Our state has been spending beyond its means for many years now,” said Assemblyman Chuck DeVore, an Orange County Republican. “We’re asking the taxpayers of California for too much of their own money to cover over a problem of our own making.”

Without a new budget in place, Schwarzenegger will notify 20,000 state employees today that they could lose their jobs, a step he put off taking last week as a deal seemed imminent.

Tomorrow he will shut down $3.8 billion of public works projects, including many already under construction, because the state doesn’t have enough money left to pay for them. That could jeopardize 32,000 jobs, Will Kempton, state director of transportation, said at a hearing today.

The cost of mothballing those projects, for example covering trenches and holes already dug in roadways, would mean about $300 million of taxpayers’ money “will be flushed down the toilet,” he said.

(Source: Bloomberg.com)